Welcome to part three of our series, “Profitability Profiles.” If you want to know more about the thinking behind these blog posts, you can check out the intro in part one, “The Story of Deadweight Bank.”
If you just want a TDLR version, here goes:
Most banks consider themselves “relationship banks,” but do they really know what that means? What constitutes a good relationship, or a bad one? And how can they attract more of the former?
To find out what “relationship banking” looks like in reality, we did some deep dives into the data of a group of real (but anonymous) banks. We pulled out some of the most interesting stories – ones with themes we think will resonate with many of readers – and are sharing them in this series.
Reminder: We’ll be walking through some of the cases, and showing how PrecisionLender can help, in our May 11 webinar.
Okay, now on to the story of “Consistency Bank.”
Our latest relationship profitability story focuses on a $20 billion regional bank in the Midwest. This bank is a high performer, cranking out earnings at the top end of their peer group, year after year. They made money through the financial crisis, big margins through the flat yield curve that followed, and chugged right through the COVID shutdowns. Asset growth is slow but steady, coming in just below peers. Their asset allocation hasn’t changed much in more than a decade. This is a bank that knows exactly who they are and goes about executing their strategy with methodical consistency.
Thus, we’ve dubbed it “Consistency Bank.”
A Disciplined Approach
So how do they manage to repeatedly best their peers? We’ll start by looking at our North Star metric, ROE (technically risk adjusted return on risk adjusted capital, or RAROC).
RAROC by Customer Profitability Quartile
Consistency Bank immediately shows an unusual profile. Each of their top 3 quartiles generate a RAROC between 13.0% and 13.3%. For most banks these quartiles all have very different returns, ranging from wildly profitable (usually with small balances) to disastrously unprofitable. But at Consistency Bank, even though the top quartile does generate the lion’s share of profits, the middle half is still a steady and healthy business. It is clear the bank is disciplined around achieving their return targets and enforces them throughout the book.
As with just about every bank we’ve seen, the bottom quartile loses money as a cohort. However, at Consistency Bank, those losses truly are outliers. Removing just the bottom 10 customers gets that quartile to breakeven, and just 14% of all relationships are unprofitable. More importantly, Consistency allocates just 3% of their total capital to the bottom quartile. Unlike most banks, they don’t tie up much dead capital here, instead allocating it to their most profitable segments. This again speaks to their disciplined, intentional approach to both pricing and credit decisions.
Consistent Cross Sell
Also contributing to the steady returns is Consistency’s clear focus on cross selling. We see very few customers with single accounts, or loan-only relationships. Even though the portfolio is a net user of funding (loan/deposit is 113%), the majority of relationships carry both loan and deposit balances. And as expected, the returns on both sides of the balance sheet are consistent as measured by ROA.
Returns by Customer Profitability Quartile
The top 3 profitability quartiles are effectively indiscernible. The bottom quartile has the usual credit issues that drag down returns on the least profitable customers (again concentrated in the bottom 10), as well as a concentration of the least profitable deposit accounts (short duration time deposits). The uniformity of the top 3 tiers is impressive. The bank has clearly pursued true relationship banking, seeking customers that need a variety of products and then holding RMs accountable for delivering a high share of the overall available wallet.
The effective cross selling goes beyond deposits, extending to fee income as well. The commercial bank averages $2,130 in annual fee income per customer. And, although the total fees generated are top heavy (more on that in a minute), nearly 10% of their relationships generate at least $1,000 annually. These results are by far the highest among the banks we evaluated. It’s especially impressive given the bank’s focus on small business, as opposed to the middle market and corporate focus of the others.
While Consistency Bank certainly lives up to its name when it comes to ROE and ROA, the actual dollars of profit contributed by each of the profitability quartiles is quite different. Like most banks, they are very top heavy both in terms of customers and in terms of the RMs that serve those customers. The top quartile of customers generates 98% of the total income for the commercial portfolio, and the top 10% of RMs are responsible for 60% of those profits. Given the steady returns across both sides of the balance sheet throughout the client base, what is driving that top heavy performance?
The top quartile has two differentiating factors. First is sheer size. Though Consistency’s portfolio has a small business focus, , it has a few “whales” that are critical to the bank’s reliable quarterly earnings.
Average Balances by Customer Profitability Quartile
Most banks are top heavy like this, but also show more of a “barbell” shape with larger accounts in the bottom quartile that are both unprofitable and big enough for it to be supremely painful. Consistency Bank has avoided that fate; their biggest customers are solid and profitable. Again, the averages hide the full story: The top 25 customers carry average loan balances north of $40 million and average deposits over $50 million. After that top group, the accounts quickly get a lot smaller.
The second factor driving profitability for the top quartile is fee income. Consistency Bank generates an average of over $8,000 in fees from its top quartile customers, and barely anything from the rest. And the top 25 carry an even bigger share here, generating an average of nearly $340,000 in annual fee income.
Average Fee Income by Customer Profitability Quartile
Also of note is how these fees come about. These fee-heavy relationships are deep and sticky, with far more ties to the bank than the rest of the customer book (and remember, the overall customer base carries more accounts per customer than most banks).
Accounts Per Customer
Consistency Bank is pretty well described by their name. They are disciplined and steady, and you can see the fingerprints of an attentive management team all over their portfolio. While impressive, the bank may also be leaving some potential returns on the table. Here are a few of our suggestions for continuing their run of success.
Fiercely Protect Those Top 25 Customers
While this advice is universal to any financial institution on the planet, it is particularly important to Consistency Bank. Their top 25 relationships stand out far above the rest of their portfolio simply because of their size. In a portfolio of small business customers, they don’t have easy replacements for any of these giants, all of which will always be ripe (and highly visible) targets for competitors. Something as simple as losing a key RM could be painful enough to show up on a quarterly earnings report. That feels like too much vulnerability.
On top of the usual relationship management stuff that we assume the bank already does (create broad and deep connections to the customer, regular contact, awareness of changes in their business, etc.), the bank should add some flavor of market benchmarking to the pricing on every aspect of these relationships. Customers of this size are usually okay with paying fees for their heavy use of bank resources, as long as those fees are fair. The bank should know what might be offered from a competitor, and pledge not to be caught flat footed. A few proactive concessions on price can go a long way in building trust and loyalty.
Move Up Market
Based on their success with their largest customers, it is safe to assume Consistency Bank offers the necessary product depth and technical expertise to serve other middle market/corporate customers. They don’t need to abandon their small business roots, but should be willing to double down on their success with cash management and servicing large balances. They’ve built much of the infrastructure and should invest in the necessary resources to fully realize the potential returns from that infrastructure. This might include additional technology, demand generation aimed at larger customers, or expanding the team to cover such customers.
Be More Willing to "Bet on the Come"
While steady, consistent, and predictable are welcome traits of a commercial portfolio, results this uniform could actually be cause for concern. As mentioned earlier, the bank has lagged its peer group in overall growth. While that has clearly been due to a long-term focus on profitability, it likely also means they’ve passed on customers that had the potential to grow into their “whales” of the future. The bank makes few mistakes, which comes from making very few exceptions to pricing or credit standards. However, it might make sense for the bank to analyze what a high potential customer looks like and be willing to make such exceptions for those that fit the criteria.
See Anything Familiar?
Chances are you may have seen a little of your bank in the story we just told. If not, you’ll likely come across an issue that hits close to home at some point in our series.
If you’re looking to make some improvements on the relationship profitability front (and really what bank isn’t?) you should attend our upcoming webinar on the topic. We’ll walk through common problems we’ve seen and how PrecisionLender’s platform can help you solve them.
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